First Horizon Undervalued, But Really Needs To Show Differentiated Growth To Re-Rate

 

I said that First Horizon (FHN) was a "show me" story back in February of this year (after fourth quarter results), and unfortunately the company really hasn't come through with any substantial evidence of differentiated growth - upside has largely come from areas like reserve releases, which is common in the sector these days. While the long-term story, including synergies from the Iberiabank deal, attractive fee-generating businesses, and an attractive geographical footprint, is still in place, "potential" isn't going to move the shares.

Up about 15% since my last update, First Horizon has basically tracked the regional bank index since then. That's good enough, I suppose, but I want to see reasons to raise estimates on the back of differentiated (positively differentiated) performance. Even so, 4% core growth can still support a fair value close to $20, as can the mid-14%'s ROTCE I expect for 2022. If First Horizon can make that turn and live up to its potential, this could be a big winner, but investors should also recognize the risk that the bank never does differentiate itself from a growth or return perspective.

 

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First Horizon Undervalued, But Really Needs To Show Differentiated Growth To Re-Rate

Sandvik Dogged By Short-Cycle Concerns As Mining Recovers Strongly

 

I was lukewarm on Sandvik (OTCPK:SDVKY) when I last wrote about the stock in October of 2020, and the shares have basically tracked the performance of the broader industrial space since then, as abundant signs of strength in the mining operations have been offset by disappointments and concerns in the tool business. While Sandvik has outperformed other industrial peers like Kennametal (KMT) and SKF (OTCPK:SKFRY), as well as some mining players like Komatsu (OTCPK:KMTUY) and Weir (OTCPK:WEGRY), Epiroc (OTCPK:EPOKY), at least, has done noticeably better.

While I think underlying demand conditions for the tools business is better than the bears fear, I am concerned about a pretty dicey history of margin performance here (relative to expectations) stretching back before the pandemic. With mining, I think the issue is more whether Sandvik can meet all the demand they are seeing without hurting margins.

The market seems to be cooling on shorter-cycle names, and that’s a sentiment risk for these shares. From a fundamental view, though, the valuation isn’t too bad, with double-digit near-term return potential and a long-term annualized return potential in the high single-digits. If Sandvik can start showing better results from the Manufacturing and Machining business (or SMS), outperformance is possible.

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Sandvik Dogged By Short-Cycle Concerns As Mining Recovers Strongly

Truist Seeing Some Short-Term Pressures, But The Long-Term Opportunity Is Attractive

 

This hasn’t been a good year so far for Truist (TFC), with the shares lagging the large bank average and most of its peers. While I don’t think there’s a single issue to point to, I get the sense that analysts and investors are frustrated by the lack of a big near-term “pop” from the SunTrust deal and the reality that there’s not a lot the company can do to drive better results until rates and loan demand recover.

I understand the short-term frustrations with Truist, but I think that overlooks the long-term opportunities from the company’s diversified revenue base (including the large insurance business), its leverage to “Main Street” lending growth, and the above-average growth potential of its geographic footprint. I believe that patience will be rewarded, and that long-term core earnings growth in the mid-single-digits can support a double-digit annualized return from here – making this a relatively attractive option in the large bank sector.

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Truist Seeing Some Short-Term Pressures, But The Long-Term Opportunity Is Attractive

U.S. Bancorp's Leverage To A Spending Recovery Starting To Emerge

 

I was bullish when I last wrote on U.S. Bancorp (USB) shares, and since the stock has outperformed its large bank peer group by a little more than 1,000bp – not bad for a roughly half-year performance. With the economy coming back to life, I believe U.S. Bancorp is finally getting some credit not only for its revenue growth leverage to consumer and business spending, but the operating leverage those high-margin payments businesses can generate.

With the standout year-to-date performance (Wells Fargo (WFC) is one of the relatively few to have meaningfully outperformed U.S. Bancorp), I can’t say that the upside I saw earlier this year is still there, and the potential returns seem more on par with other high-quality large banks. That said, if U.S. Bancorp can leverage more growth out of its fintech investments (and/or more operating leverage), there could still be some upside here.

 

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U.S. Bancorp's Leverage To A Spending Recovery Starting To Emerge

First Republic Remains A Top-Notch Growth Bank Stock

 

When the biggest bearish argument you can come up with is "I'm not sure how long the bank can continue to grow earnings at a double-digit clip", you know you're looking at a pretty good bank. Such is the case with First Republic (FRC), and I continue to believe this high net worth-focused lender as a long run of exceptional growth ahead of it, as the company continues to benefit from a strong networking effect and very strong underwriting.

Valuation is difficult. By conventional approaches, First Republic looks quite expensive, but then this is not a conventional bank. While metrics like ROTCE can help separate winners and losers when growth rates are similar, First Republic's growth is well beyond "exceptional" and conventional metrics just don't work as well here. Bank investors have historically been willing to pay robust premiums for banks with outsized revenue, earnings, and tangible book growth, and I believe First Republic is well-placed to continue doing just that.

 

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First Republic Remains A Top-Notch Growth Bank Stock

PNC Financial's Core Operations Still Under Some Pressure, But The Future Is Bright

 

There was no reason to think that second quarter results would show a big operational shift for banks, and that has been the case so far, with banks still seeing pressure from flat spreads and weak loan demand, partly offset by reserve releases driven by better-than-feared credit quality evolution. So too with PNC Financial (PNC), where core net interest income was okay relative to expectations, but where core growth was still pretty soft.

I’m not bothered that this quarter’s results here weren’t outstanding, and they don’t change my view that this is a high-quality bank for the long term. With BBVA’s (BBVA) Compass in hand, PNC has some attractive growth opportunities – both in terms of expanding its footprint in higher-growth markets and in improving the operations at Compass. As the economy continues to recover, I expect this middle market-driven bank to benefit, I expect healthy growth for some time to come.

PNC isn’t a bargain basement stock, but I do think the valuation is reasonable, and I think long-term investors can reasonably expect an annualized long-term total return in the very high single-digits from here.

 

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PNC Financial's Core Operations Still Under Some Pressure, But The Future Is Bright

AngioDynamics: Focusing On Three Credible Growth Drivers And Targeting Growth Acceleration

 

After enjoying a strong run from the fall of 2020 through to the spring of this year, AngioDynamics (ANGO) shares have flattened out. I would attribute at least some of this to a more cautious market towards smaller med-tech, but also some level of “wait and see” on the part of investors regarding management’s ability to drive a sustained improvement in the business on the back of its thrombectomy, atherectomy, and oncology electroporation technologies.

AngioDynamics’ spotty execution history and higher investor expectations were significant factors in my neutral stance on AngioDynamics back in April, and the shares haven’t done much since then. I liked the better-than-expected fiscal fourth quarter results and the improved guidance for fiscal 2022, and I still see a path to a fair value close to $30, but this remains a riskier-than-average execution-driven story with not all that much following on the Street.

 

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AngioDynamics: Focusing On Three Credible Growth Drivers And Targeting Growth Acceleration

Fastenal Seeing Better Results, But The Market Seems Less Interested In Short-Cycle Stories Now

 

Despite strengthening economic conditions, shorter-cycle industrials haven’t really been performing all that well, and Fastenal (NASDAQ:FAST) has been no exception. This industrial distributor did a little better than expected in the second quarter, and continued to show progress on long-term business-building initiatives, but it wasn’t thesis-changing outperformance and investors seem ready to call it a day with earlier-cycle plays.

Modest year-to-date underperformance versus the S&P 500 and the broader industrial sector certainly has to be kept in context – over the long term Fastenal has been a great stock, and there’s nothing wrong with the business. Valuation remains problematic for me, though, and unless you expect significant beat-and-raise quarters in the near-future or are a more value-insensitive investor who believes in just buying quality and holding through thick and thin, I don’t see much appeal right now.

 

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Fastenal Seeing Better Results, But The Market Seems Less Interested In Short-Cycle Stories Now

Strong Semiconductor Demand Boosting Yaskawa Electric Beyond The Rising Industrial Tide

 

YASKAWA Electric's (OTCPK:YASKY) (6506.T) fiscal first quarter update earlier this month was a piece of welcome news for the industrial automation sector, as YASKAWA not only performed meaningfully better than expected, but management also upgraded its order, revenue, and profit guidance for the year. It remains to be seen whether industrial order momentum will peak around midyear as management now believes, but customers across a range of industries are definitely willing to make capital investments again.

I wasn't all that impressed with YASKAWA's value back in October of 2020, and though the ADRs have kept pace with the S&P 500 and the broader industrial sector since then, the shares have underperformed the likes of ABB (ABB) and Rockwell (ROK). While I do see the possibility of further upside to YASKAWA's recently-raised guidance, I see this as a momentum/cycle play and not much of a long-term value at these levels.

 

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Strong Semiconductor Demand Boosting Yaskawa Electric Beyond The Rising Industrial Tide

Business Is Improving For MSC Industrial, But The Street Isn't So Impressed

 

One of the frustrating realities of the market for many investors is that stocks can often move in anticipation of underlying shifts in the fundamentals - the "buy the rumor, sell the news" saying that investors will hear from time to time. In the case of shorter-cycle companies/stocks like MSC Industrial (MSM), industrial end-demand is indeed improving nicely, but the shares have underperformed as the market is starting to look past the short-cycle recovery story.

As I've said in the past, the cycle is going to do what the cycle is going to do, and I believe more of MSC Industrial's performance potential rests on management's ability to execute on new programs meant to increase share, drive sales growth, and improve margins. Given the many and varied disappointments of the past, some skepticism is still in order, though recent results have looked a little better.

I would say that MSC Industrial is still more of a hold today. I don't think the cycle has run its course, and I don't think the shares are overpriced, but I also don't have a lot of confidence in a bull story that rests on management execution given past execution issues. The dividend yield isn't bad, though, so investors looking for income-generating options in the manufacturing sector may find this name a little more attractive.

 

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Business Is Improving For MSC Industrial, But The Street Isn't So Impressed

Lundbeck Really Needs Clinical Wins And Post-Pandemic Re-Acceleration

 

I called H. Lundbeck (OTCPK:HLUYY) (LUN.CO) (“Lundbeck”) a high-risk/high-reward proposition in my last update on the company, and since then it is the risks that have materialized. Although first quarter results weren’t bad, and revenue should improve in the second half of the year on post-pandemic normalization, the company didn’t get the big clinical win it needed with its Rexulti label extension efforts in Alzheimer’s-associated agitation.

I do believe that a resumption of more normal in-person sales calls and patient appointments will help the business, but 2021 looks like another tough year for sentiment unless the high-risk Rexulti study in borderline personality disorder delivers an unexpected win and/or Vyepti really picks up momentum. Expectations are low, and I do see some value here, but it will difficult for undervaluation to translate into stock outperformance without some sentiment-shifting good news.

 

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Lundbeck Really Needs Clinical Wins And Post-Pandemic Re-Acceleration

Wells Fargo Offers Near-Term Rate Leverage And Long-Term Turnaround Potential

 

I’ve been bullish on Wells Fargo (NYSE:WFC) for a while – less on the basis of thinking it’s great and more on the basis of thinking “it’s not that bad” – and over the last six months this call has finally started to work. A shift toward “risk on” banks leveraged to the post-pandemic recovery has certainly helped, particularly with Wells Fargo’s well-above-average asset sensitivity, as has some increased confidence on management’s restructuring/turnaround plan and progress toward resolving the asset cap that has constrained the business for some time.

As one of the three banks in the U.S. with double-digit deposit share, Wells Fargo has a real chance of becoming one of the long-term winners as smaller “run of the mill” regional and community banks are squeezed out over time. Moreover, a streamlined bank more focused on higher-return opportunities in consumer and commercial banking has a better chance of recovering to mid-teens returns on tangible common equity over the next three to five years.

Given where things stand today, the investment argument for Wells Fargo is more complicated. I think investors who want an underappreciated story could do better with Citigroup (NYSE:C) or Truist (NYSE:TFC) among the larger banks now, and I think JPMorgan (NYSE:JPM) remains an appealing longer-term hold as well (with Bank of America (NYSE:BAC) moderately less attractive). Still, I do see annualized total return potential still in the high single-digits, which is still above the long-term norms of the sector, and there is still upside potential from the turnaround/restructuring efforts.

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Wells Fargo Offers Near-Term Rate Leverage And Long-Term Turnaround Potential

Lennox Leveraging Incredibly Strong Residential HVAC Demand

 

The HVAC space has stayed pretty hot in 2021 despite robust valuations, as the major players in the U.S. market, excluding Daikin (OTCPK:DKILY) have continued to outperform the broader industrial sector. Although the companies have been relatively careful with guidance and the sell-side continues to fret about a potential slowdown in the residential space, investors seem quite willing to pay rich multiples for growth rates that are admittedly, for now, well above what other sectors are offering.

Since my last update on the company in the fall of 2020, Lennox Intl (LII) shares have underperformed the broader industrial sector and most of its HVAC peers (except Daikin), though they’re still up about 15%. That could make some sense in the context of Lennox’s greater reliance on U.S. residential demand and less leverage to commercial HVAC in general and OUS HVAC in particular.

I still have trouble reconciling the multiples in the HVAC space today, and Lennox is no exception. Although I have pretty bullish growth expectations (relative, at least, to the sell-side), I can’t see a path to better than mid-single-digit long-term annualized returns from here, and that’s not attractive enough for me.

 

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Lennox Leveraging Incredibly Strong Residential HVAC Demand

PNC Financial Still Offers A Lot To Like As It Shifts To Recovery And Growth

 

PNC Financial (PNC) stands out as one of the very few banks I follow that doesn’t generate many complaints – the worst that’s usually ever said about PNC is that management takes a conservative approach and the business isn’t especially flashy. That’s fine with me, though, and few banks have generated better long-term returns than PNC.

With the purchase of BBVA’s (BBVA) U.S. banking assets complete, PNC has a coast-to-coast footprint and a presence in 29 of the 30 largest MSAs. Moreover, it’s a footprint skewed to some attractive growth markets, including the Southeast U.S., and a greater-than-average exposure to corporate lending.

I was bullish on PNC with my last update and the shares have continued to modestly outperform. While today’s price doesn’t offer an eye-popping total annualized return, I still believe PNC will continue to generate above-average returns, and I believe PNC will be a long-term winner in the ongoing consolidation of the U.S. banking sector. At a minimum, I think it’s a good candidate as a core long-term holding.

 

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PNC Financial Still Offers A Lot To Like As It Shifts To Recovery And Growth

Hexcel Has Bounced On Bullish Aerospace And Commodity Sentiment

 

When I last wrote about Hexcel (HXL) in January of this year, I underestimated the potential tailwind the shares could get from a further sentiment shift back toward later-cycle recovery stories (like aerospace) and material plays in an inflationary environment. With that, the shares have risen nearly another 40%, underperforming a few other aero plays like Spirit AeroSystems (SPR) and Universal Stainless (USAP), but outperforming names like Carpenter (CRS), HEICO (HEI), and Woodward (WWD).

At this point I don't think Hexcel shares offer a particularly attractive long-term return, but I fully acknowledge that cyclical stocks overcorrect on both ends of the cycle, and the outlook for the company's commercial aerospace business (especially the wide-body business) should only improve from here.

 

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Hexcel Has Bounced On Bullish Aerospace And Commodity Sentiment

MaxLinear Executing Well, But Growth Opportunities Like Data Center Are Becoming More Crucial To The Bull Case

 

MaxLinear (MXL) has had its operational challenges over the years, but with massive MIMO transceivers going into production, wireless backhaul picking up, and a long-awaited ramp with Amazon (AMZN) for its 400G PAM-4 on the way, better days could be on the way. It’s not as though the stock has been languishing either, with the shares up about 8% since my last update, outperforming the basically flat performance of the SOX since then.

I still don’t love the valuation here, but that’s a sector call/issue more than a MaxLinear-specific issue. I do still worry that Street and investor expectations for the PAM-4 business are too high (and that the company will struggle against Marvell (MRVL) and Broadcom (AVGO)), and the supply constraints that are limiting upside today could persist. I do like the connected home business, though, and ongoing momentum in 5G wireless would be a big help.

All told, I’m pretty lukewarm on MaxLinear. I think stocks like Broadcom (which I own), Renesas (OTCPK:RNECY) and STMicro (STM) offer better valuations, but MaxLinear could surprise on growth (in either direction), and the modeling upside for MaxLinear in a bull scenario is higher. If you feel like taking more risk in the pursuit of growth, this is a name to consider (as would Lattice (LSCC) and Silicon Labs (SLAB)), but it’s likely a tougher sale with the GARP/value crowd.

 

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MaxLinear Executing Well, But Growth Opportunities Like Data Center Are Becoming More Crucial To The Bull Case

Daikin's Reinvestment Plans Have Undermined Near-Term Growth And Sentiment

 

It may take money to make money, but that doesn’t mean that the Street is happy to hear it when company managements choose to reinvest in product R&D and sales channel development. That is precisely what Daikin Industries (OTCPK:DKILY) (6367.T) is doing, as the company aims to take more share in the U.S. market, but the end result is an earnings outlook around 7% to 10% lower than previously expected over the next few years.

Although I thought it was a little pricey (as were/are most HVAC companies), I liked Daikin back in October of 2020 and the shares did outperform peers like Carrier (CARR), Lennox (LII), and Trane (TT) until around mid-February, when the company began talking down numbers. All told, the shares are still up some from that last update, but well short of what its HVAC peers have done over that time.

The valuation looks interesting here on a long-term basis, but the prospect of iffy margin leverage over the next few years isn’t great for sentiment, nor is the likelihood that the company’s efforts to reinvest in the business, continue to pay a dividend, and pursue around $6B of M&A will lead to more leverage. Patient investors should take a look, but softer near-term results are a real risk.

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Daikin's Reinvestment Plans Have Undermined Near-Term Growth And Sentiment

Sika Riding On Its Leverage To Greener Construction

 

Quite likely one of the best-run companies I follow, Sika (OTCPK:SXYAY) (SIKA.SW) shares have “only” kept pace with the broader industrial sector since my last update on the company, as well as keeping pace with BASF (OTCQX:BASFY), while Saint-Gobain (OTCPK:CODYY) has done a fair bit better and RPM (RPM) a fair bit worse. Keep in mind, too, that “only” keeping pace still means that the shares are about 30% higher than they were at that last article.

Sika is already seeing a strong post-pandemic recovery, with particular strength in Asia (NASDAQ:CHINA) offsetting a more sluggish recovery in the U.S.. As the year rolls on, I expect good underlying demand improvement, and I love Sika’s long-term exposure to greener building trends in non-residential and infrastructure, leaving the company well-placed to take advantage of government programs aimed at promoting a greening of those end-markets.

Price/value remains a problematic issue if you’re a more value-oriented investor. I believe Sika could generate organic revenue growth double that of global GDP, with M&A adding in more on top of that, and I likewise see room for more operating leverage. Even with those assumptions in place, though, the valuation is very much in growth stock territory.

 

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Sika Riding On Its Leverage To Greener Construction

Recent Sluggishness In Schneider Electric's Share Price Worth Watching

 

First things first – I’m not an advocate of focusing on short-term stock performance. I am an advocate of opportunism, though, and sometimes short-term wobbles can create windows of opportunity. Such could be the case today with Schneider Electric (OTCPK:SBGSY) – the shares have been a little sluggish since my last update and on a year-to-date basis relative to the wider industrial space and peers like ABB (ABB), Eaton (ETN), and Siemens (OTCPK:SIEGY).

I remain a big believer in both the macro opportunities in front of Schneider (automation, digitalization, electrification, et al) and the company’s ability to leverage those opportunities into above-average revenue growth, margin improvement, and free cash flow. I can’t say that I find the shares a screaming bargain today, but the long-term prospective return is still reasonable and a reasonable return from a good company that I believe has more leverage to outperformance isn’t a bad thing.

 

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Recent Sluggishness In Schneider Electric's Share Price Worth Watching

Hurco Seeing Real Evidence Of The Turn

 

There have been some “fits and starts” to the post-pandemic recovery, including mixed trends on capital spending and manufacturing activity in some sectors, but with fiscal second quarter results in hand, Hurco’s (HURC) recovery seems to be solidly underway, and looking around the industry, I expect “recovery growth” over at least the next few quarters.

Hurco has lagged the broader industrial sector since my last update, but done a little better than my own “peer group” of metalworking-driven companies. The stronger evidence of recovery should be good for the stock from here, and I do believe the shares are undervalued below $40 in the near term (and priced for longer-term annualized returns in the double-digits), but this is an unfollowed, illiquid company, so investors need to understand the risk that this remains overlooked for an extended period of time.

 

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Hurco Seeing Real Evidence Of The Turn

More 'Hurry Up And Wait' For Accuray, But The China Opportunity Is Coming Through

 

It’s been a rough go for Accuray (NASDAQ:ARAY) since my last update on the shares. The combination of a weaker tape for small-cap med-tech and a lackluster fiscal third quarter hasn’t been a good one for the shares, which have lost close to 20% of their value since that last article – despite not much real change in the outlook. I get that Accuray is a frustrating stock to hold, and it has been for some time – investors have been waiting years for the supposed advantages of the CyberKnife system, the improvements to the Tomo platform, and the opportunities in China to deliver, and we’re still not quite there yet.

That said, I do believe the opportunity in China is real, and the technological improvements to Accuray’s systems, as well as a shift toward more hypofractionation in radiation oncology could finally be the right combination to unlock the potential here. I continue to believe that $6 to $7 is a fair price for now, but if the opportunity in China lives up to its potential, a double-digit share price is not hard to imagine.

 

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More 'Hurry Up And Wait' For Accuray, But The China Opportunity Is Coming Through

Citigroup Still Has A Lot Of Work And Potential Gains, Ahead Of It

 

It’s still early days for Jane Fraser’s tenure as the CEO of Citigroup (NYSE:C), but she’s off to a good start with the Street generally liking the news of the company’s plan to exit its non-core global consumer banking businesses. It remains to be seen what the company will do with respect to building up the U.S. operations, including potential M&A, but focusing on businesses with higher prospective returns is definitely the right move.

Citigroup shares have slightly outperformed the larger banking group since my last update, and I continue to think there’s a good argument for owning these shares as a play on a leaner, more profitable bank with strong global corporate finance capabilities and an improving core consumer bank. Low single-digit long-term core growth can still support a double-digit annualized return from here, and I believe this is an interesting risk/reward opportunity for investors willing and able to take more risk.

 

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Citigroup Still Has A Lot Of Work And Potential Gains, Ahead Of It

As COVID-19 Enthusiasm Fades, Abbott Labs Worth Closer Watching

 

I wasn’t all that bullish on Abbott Labs (ABT) back in the summer of 2020, as although I view this as a very high-quality med-tech company, the valuation seemed too rich. Add in my concerns about COVID-19 testing contraction in 2021 and beyond (something I’ve mentioned in reference to Agilent (A), Hologic (HOLX), and Thermo Fisher (TMO) among others more recently), and I didn’t like the set-up for the shares.

Since then, the shares have risen about 12% - less than half the gain of the S&P 500 and about 700bp shy of the larger med-tech group. That’s not quite enough to put Abbott in my “unfairly cheap” bucket just yet, but the prospective long-term return is now closer to the high single-digits and that’s enough to get my interest. Add in M&A optionality, and this is definitely a name to watch, if not consider outright.

 

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As COVID-19 Enthusiasm Fades, Abbott Labs Worth Closer Watching

Broadcom Executing Well, But Still Not Getting Its Due

 

Broadcom (AVGO) has remained a somewhat frustrating stock to own – I say “somewhat”, because while the shares aren’t far from their all-time high (about 5%) and have risen around 60% over the past year, they’ve still continued to lag the broader semiconductor space a little bit. I suspect this is due in part to the fact that management runs the business for long-term margins and growth (as opposed to shorter-term metrics), as well as the slower-growing software assets.

In any case, I continue to believe that Broadcom offers a good mix of quality and value. Broadcom has exceptionally strong businesses in multiple growing markets (including switching/routing, broadband access, custom ASICs, and front-end phone components), and I like the combination of mid-single-digit long-term revenue growth potential and exceptional (high 50%s) non-GAAP operating margins. With those drivers, I believe Broadcom shares should trade closer to the mid-$500s.

 

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Broadcom Executing Well, But Still Not Getting Its Due

JPMorgan Likely To Leverage The Recovery To Earn Even Higher Returns

 

Some companies are good defensive plays, others are good offensive plays. A rare few are both, and I believe that JPMorgan (JPM) qualifies. Strong operating scale and risk management practices mitigated the damage from the pandemic, and the company is now well-positioned to leverage its scale to drive even more share growth in the recovery, leading in turn to greater profit growth and share price appreciation.

I follow a lot of well-run banks, but I believe JPMorgan is still the best of the bunch, and I believe 17.5%-plus ROTCEs are possible on a long-term sustained basis, as well as GDP-plus growth, as the bank is one of the few capable of functioning as a truly national banking franchise in both commercial and retail banking.

As the Street has shifted from a preference for quality to a preference for growth, JPMorgan has lagged some this year, but as a long-term investor, I don’t need my holdings to beat the peer growth every month I hold them. I still see a high single-digit annualized return potential here, and though JPMorgan is not the cheapest bank, I think the combination of quality, value, and long-term opportunity should keep it in serious contention for most investors.

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JPMorgan Likely To Leverage The Recovery To Earn Even Higher Returns

Important Announcement

Hello all,

It has been a long time since I've updated the format of the blog, and a few things about the platform have changed (including support for various functions).

The long and short of it is that I'm pondering whether maintaining this site is worth the bother. I'd like to hear from you if you find this useful. You can use the article comments or email me; whatever you find more convenient. I know there are many people who'd prefer to just read in silence, but feedback will determine whether I update the blog, keep it as is, or close it/delete it entirely.

Thanks for any feedback you all choose to provide. 

Best,

SS

<<EDIT>>

I wanted to add a bit to this in the interests of clarity. I am NOT contemplating an end to my research/writing at this point. So, I still plan to write about the companies/stocks that interest me. I am mostly just curious if this blog is a useful place for you all to come to find my work.

In years past, I sometimes wrote for multiple publishers at once, so this was a useful "central locale" to see what I was up to. Now, though, about 99% of my work is for Seeking Alpha, and they have their own ways to follow my work - which may be more convenient for you all.

So, again, no thoughts today about quitting the work. Just wondering if people get use out of this particular page/portal.

Thanks again!

Another Tough Quarter For FEMSA, But Recovery Comes Next

 

As Mexico’s economy reopens and recovers after the COVID-19 pandemic, FEMSA (FMX) has started to come back to life as well. Traffic is starting to improve in FEMSA’s OXXO stores, and margins have held up surprisingly well through this challenging time.

There are still multiple attractive drivers for FEMSA, including the expansion of the OXXO concept (particularly in Brazil), leveraging new distribution agreements (selling more Modelo through its distribution agreement with ABInBev (BUD)), launching the spin digital wallet, and driving more scale in the pharmacy business. On the other hand, there are also challenges, including standing doubts about the company’s capital allocation into lower-margin areas like logistics and distribution.

I’m still positive on FEMSA and I still see the prospect of double-digit long-term annualized returns on the back of mid-to-high single-digit revenue and FCF growth. Although management’s focus on long-term opportunities isn’t necessarily in sync with the Street’s fixation on short-term results, I believe patience will be rewarded.

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Another Tough Quarter For FEMSA, But Recovery Comes Next

Lexicon Pharmaceuticals Still A Very High-Risk/High-Reward Biopharma Name

 

As the clock keeps ticking, Lexicon Pharmaceuticals (LXRX) have continued to skid – falling about a third since my last update as investor enthusiasm over the company’s opportunity to disrupt the heart failure market with its SGLT-1/2 inhibitor Zynquista as faded. While nothing has changed, that’s actually part of the problem – Lexicon is going to need a partner to successfully launch this drug, and every month without a partner erodes Street confidence in the long-term potential of the drug.

Valuing Lexicon today remains exceptionally difficult as there are a lot of unknowables that have a big influence on the valuation. If AstraZeneca (AZN) and Lilly (LLY) (and Boehringer Ingelheim) report strong positive data from the DELIVER and EMPEROR-Preserved studies of their SGLT-2 drugs in patients with preserved ejection fraction, differentiating Zynquista in the market will be even harder. Likewise, if Lexicon has to go it alone (as opposed to securing a larger pharmaceutical company to market/co-market the drug), the road ahead is considerably rockier.

I’ve reduced my fair value on Lexicon to account for a longer, slower revenue ramp on Zynquista. Still, it’s worth mentioning again that this is a stock where the price could move rapidly on the basis of competitor clinical updates, FDA action on the Type 1 diabetes indication for Zynquista, and/or the results of the company’s Phase II proof-of-concept studies for pain drug LX9211.

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Lexicon Pharmaceuticals Still A Very High-Risk/High-Reward Biopharma Name

Advanced Energy Industries: Temporary Supply Challenges Don't Hurt The Long-Term Case

 

Severe supply constraints for semiconductors and other electronic components claimed another victim with Advanced Energy Industries’ (AEIS) second quarter guidance, sending the shares down 10% in response. Although the shares have recovered some lost ground, they’re still down a bit from the time of my last update and have underperformed peers like MKS Instruments (MKSI), Comet Holdings (COTN.SW), and Delta Electronics (OTC:DLEGF).

On a core level, I’m not too troubled by these supply-related disruptions to the business. The Semiconductor business remains in very strong shape with respect to market share, backlog, and capacity growth, and I expect improving demand in the Industrial segment through 2021. I still expect AEIS to generate long-term revenue growth of around 5% to 6% and FCF growth in the high single-digits, and at today’s price those growth rates support a double-digit annualized prospective rate of return.

 

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Advanced Energy Industries: Temporary Supply Challenges Don't Hurt The Long-Term Case

Worries About Growth Keeping A Lid On PRA Group Shares

 

Despite some strong quarterly results, PRA Group (PRAA) shares have gone nowhere fast this year, as investors remain more concerned about future growth prospects than excited about strong recent performance. This is understandable, to a point, but I do believe the Street is undervaluing the long-term value of meaningful efficiency improvements in the operations even if the future supply of collectable receivables is lower than previously hoped.

My fair value range on PRAA shares has been in the $40 - $46 range over my last two updates (here and here), and that's basically still the case, as model refinements narrow that valuation range to $41 to $45. A faster pace of purchasing would likely be the best source of near-term upside, followed closely by an even better sustained trend of cash operating costs, while a return to more activity in legal-channel collections and bankruptcies may not be as well-received by the Street.

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Worries About Growth Keeping A Lid On PRA Group Shares

FirstCash Likely Past The Worst, And The Long-Term Growth Potential Comes Back Into Focus

 

Pawn shop operator FirstCash (FCFS) is still in for a few more rocky quarters, but recent data from the company do support the idea that pawn loan demand is bottoming out. It’s going to take time to rebuild retail inventories and pawn loan balances, but the arrow is pointing up and I expect the story to once again shift toward the long-term growth opportunities ahead of the company in Latin America.

As is often the case, the share price has moved ahead of the actual improvements in reported numbers. Up about a third from my last update, I can’t say that the Street is ignoring or avoiding this name now. Still, assuming the company can get back on a trajectory to mid-single-digit growth (relative to pre-pandemic norms), the shares do still offer solid upside on the basis of improving cash flow generation in the U.S. operations funding more dividends and buybacks and a long growth runway in Latin America outside of Mexico.

 

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FirstCash Likely Past The Worst, And The Long-Term Growth Potential Comes Back Into Focus

Tenneco Roars Ahead Of The Pack On Strong Earnings, Guidance, And Build Outgrowth

 

When I last wrote about Tenneco (TEN) I said that I saw, “a path to a significantly higher share price” in the mid-teens, but that the execution risks were still high. Not only did Tenneco deliver a very strong first quarter, but it was also one of the few parts suppliers to guide to both higher full-year and second quarter earnings, as Tenneco’s business mix has left it relatively well-shielded from the semiconductor shortages hitting the sector.

I believe Tenneco’s heavy debt load and business mix still merit a higher discount rate than its peer group (which it has smoked in terms of share price performance since my March piece), but the company has definitely bought itself breathing room on the debt issue and showed some impressive operating leverage this quarter. I still think this is a difficult “thread the needle” story, but I can support a cash flow-based fair value in the mid-to-high teens.

 

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Tenneco Roars Ahead Of The Pack On Strong Earnings, Guidance, And Build Outgrowth

SPX Flow Continues To Build A More Positive Case For Itself

 

As a long-term investor, I try not to spend too much time fretting over short-term price movements, but I do think the recent performance of SPX FLOW (FLOW) highlights the impact valuation and expectation can have on performance. SPX FLOW shares are up modestly (around 7%) since my last update, lagging the mid-teens performance of the larger industrial group, despite what I thought was a strong Investor Day presentation and a very good set of first quarter results.

I like management’s “80/20” strategic plan and the decision to focus more attention on growth opportunities in the Nutrition & Health and Industrial segments, as well as the decision to deploy more capital into M&A. I think management’s target of mid-teens adjusted operating margins in 2023 could be a little aggressive, but I do think the company is on a better path now as it transitions from a turnaround story to a quality (if cyclical) growth story.

Between the Investor Day presentation, the first quarter results, and trends I see across the company’s end-markets, I’m more comfortable with more bullish assumptions, and I think M&A could push the longer-term revenue growth rate closer to the high end of the mid-single-digits. Assuming that FCF margins move into the low double-digits (and there could be upside here if management really delivers on efficiency efforts), I think there’s a potential high single-digit long-term annualized return here, and that’s pretty attractive on a relative basis.

 

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SPX Flow Continues To Build A More Positive Case For Itself

The Pullback In Pacific Biosciences Makes For A Much More Interesting Opportunity

 

As the frenzy that drove many growth stocks, particularly in life sciences, to eye-watering multiples earlier this year has faded, Pacific Biosciences (PACB) (“PacBio”) shares are getting more interesting to me again. To be as clear as I can be right from the beginning, I think PacBio has great technology and growing use-cases in sequencing, and I think the company now has exceptional management and a good growth plan. My only major issue is valuation.

I’m modeling long-term revenue growth (2020-2030) of close to 30%/year on a compound basis, with operating profitability in 2026 and positive free cash flow in 2025, and I believe the company could exit 2030 with a FCF margin north of 30% - though a lot depends on the strategic decisions made between now and then and the implications those will have for R&D and SG&A spending. More to the point, I believe PacBio has the best long-read sequencing technology out there, and with significant improvements in throughput and cost, I believe the use of long-read technology is going to accelerate significantly in the coming decade.

PacBio isn’t conventionally cheap today, and I wouldn’t really expect it to be, as there is momentum in the business, strong partnerships, and good funding/liquidity. A continuation/reacceleration of this sell-off to $20 or below would make for an easy decision, but even in the mid-$20’s it’s a tempting name.

 

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The Pullback In Pacific Biosciences Makes For A Much More Interesting Opportunity

Neurocrine Biosciences: Pandemic Pressures And Few Pipeline Catalysts Continue To Weigh On NBIX

 

About the best thing I can say about Neurocrine Biosciences (NBIX) so far for 2021 is that the shares have managed to outperform a weak tape for biotech (the SPDR S&P Biotech ETF (XBI) is down about 10% versus Neurocrine’s flattish performance), though that comparison looks much worse for NBIX shares over a 12-month period.

I’d previewed some of the drivers of this weakness in earlier pieces – namely challenges to the Ingrezza franchise from the pandemic and a pipeline with few high-probability value-driving readouts. Indeed, Ingrezza has been quite weak, and while blaming that weakness on the pandemic is plausible, it doesn’t fix anything.

I still own these shares and I’m still bullish on the long-term potential, but I’ve cut back my Ingrezza expectations (again). I continue to believe that crinecerfont is an underappreciated asset, but with a pipeline still weighted more toward early-stage assets (there will be several Phase II studies underway by the end of 2021), this is a stock that could take some time to work again.

 

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Neurocrine Biosciences: Pandemic Pressures And Few Pipeline Catalysts Continue To Weigh On NBIX

Alnylam Executing To Plan, But Catalysts Could Be Harder To Find In The Near Future

 

RNA interference (or RNAi) specialist Alnylam Pharmaceuticals (ALNY) has held up okay in what has been a tougher tape for biotech, with the shares down about 5% since my last update versus a 15% decline for the SPDR S&P Biotech ETF (XBI). Since that last article, Alnylam has posted a couple of good quarters, as well as some positive incremental data on significant clinical programs.

Alnylam is likely going to find itself in a “hurry up and wait” trading pattern for a few quarters, and that can be tough for the share price. Key data on the amyloidosis program won’t be coming until 2022, and early-stage updates on other clinical programs aren’t likely to move the shares all that much one direction or another.

I do believe, though, that these shares are more than 20% undervalued today, and there are numerous early-stage clinical programs that could drive substantially higher value as they mature (assuming clinical success, of course). There are risks here, including clinical trial failure and competitive drug development, but I believe Alnylam still ranks as a high-quality biotech idea.

 

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Alnylam Executing To Plan, But Catalysts Could Be Harder To Find In The Near Future

Renesas Electronics Looking To Rise Like A Phoenix From A March Fab Fire

 

Between a painful inventory correction in 2019, the 2020/2021 pandemic, an earthquake, and a March fire in a key fab, Renesas Electronics (OTCPK:RNECF) (OTCPK:RNECY) (6723.T) has been snake-bit here of late, leading to a weak share price performance – the shares are down about 8% since my last update (the ADRs have done modestly better), underperforming the SOX by close to 10% over that short period.

Renesas has scrambled to minimize and mitigate the impact of the fab fire, and they’ve done quite a good job here. Far from a “lost year”, Renesas is still likely to see very strong revenue growth in 2021 on recovering auto and industrial demand, with solid margin leverage even accounting for the unexpected fire-related costs.

The biggest risk I see for Renesas is that the company ends up losing more microcontroller (or MCU) share in autos to NXP Semiconductors (NXPI) and others like Texas Instruments (TXN) and STMicro (STM), and that efforts to diversify the company’s addressable markets (including the Dialog Semi acquisition) don’t go to plan. I think those risks are more than captured by the share price, though, and I believe the shares offer an attractive double-digit long-term annualized return.

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Renesas Electronics Looking To Rise Like A Phoenix From A March Fab Fire

Weaker Margin Guidance Overshadowing Progress At Veeco Instruments

 

I’ve written this several times in the past, but it bears repeating – margins matter more in sectors like semiconductor equipment than some analysts and investors believe. Semi equipment company Veeco (VECO) is doing pretty well from a revenue and order flow perspective, and I believe the business is on the cusp of meaningful acceleration, but weaker margin guidance weighs on valuation in the near term and has driven underperformance since my last update.

Veeco is a company that has long struggled to get its ducks in a row, but I believe the outlook is bright. In addition to a strong-moat position in data storage, Veeco has growth opportunities in areas like annealing, EUV mask blanks, GaN chip production, and chip packaging that shouldn’t be ignored. The shares need better margin momentum to outperform, but in a sector that offers few bargains, Veeco is worth a look on its leverage to ongoing capacity expansion spending.

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Weaker Margin Guidance Overshadowing Progress At Veeco Instruments

ITT Inc. Already Seeing Strong Incrementals Ahead Of A Full Revenue Recovery

 

Expectations were already high for late-reporting ITT Inc. (ITT), but this multi-industrial nevertheless managed a good top-line beat and an even better performance on margin leverage. Better still, the company broke with a general trend of relatively conservative guidance for the rest of 2021.

I previewed my "but" in the last piece; namely, that Street expectations had already risen pretty notably for this company. The shares have lagged a bit since that last piece, rising around 10% and slightly outperforming the S&P 500, but slightly underperforming the broader industrial sector. Again, I think already-high expectations are part of the issue, as well as a little more investor wariness about auto volume growth in 2021 on component shortages.

Bargains are few and far between in the industrial sector today, and I think ITT can still outperform as important end-markets like aerospace, chemicals, and refining recover in 2022 and beyond. I'd categorize the potential returns here as more "okay" than "compelling", but it is still a relative bargain compared to many industrial names and one that I think has better exposure to later-moving sectors as the recovery matures.

 

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ITT Inc. Already Seeing Strong Incrementals Ahead Of A Full Revenue Recovery

A Bumpy Initial Recovery Hasn't Really Hurt Fastenal

 

High-multiple stocks can often be more vulnerable to disappointments, but that hasn’t been the case for Fastenal (FAST). Despite three straight monthly misses on sales and a very slight negative downward trend in sell-side EPS expectations, the shares have held up well since my last article – appreciating another 10%-plus since then. That’s a little worse than the wider industrial sector, including the recovery star Parker-Hannifin (PH), and worse than Grainger (GWW) (which has risen more than 20% since the time of my last Fastenal article), but still better than the S&P 500.

The reopening/recovery of the U.S. manufacturing sector has been a little bumpy, and I wouldn’t be surprised if that is the case for the remainder of 2021, but I don’t see it as a major threat to Fastenal. The company continues to outgrow the underlying economy and there’s a potential path to better margins for at least the next year or two, as well as a growing revenue base as the company expands the reach of the business. Valuation is still problematic, but it’s tough to see how these shares would trade at conventionally cheap multiples without a serious market decline.

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A Bumpy Initial Recovery Hasn't Really Hurt Fastenal

Truist Building Toward Better Growth And Margins

 

Southeastern banking giant Truist (TFC) has continued to lag many of its peers since my last update (and over the last year), as the market has been pretty impatient regarding the expected savings from the SunTrust merger and stabilization in the net interest margin. Still, the shares are up around 25% since that last article, more than doubling the return of the S&P 500.

Although I don’t believe that Truist shares are wildly undervalued (few of the quality banks are), I do believe that there’s still a relative value trade here, and I still believe that Truist isn’t getting its full due. With one of the best operating footprints in the country, surplus capital to accelerate growth, and a potential “goldilocks” operating environment for a few years, I believe Truist has a good chance to deliver beat-and-raise quarters, particularly as I believe that this slower, more deliberate pace of merger integration could ultimately drive better-than-expected long-term benefits.

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Truist Building Toward Better Growth And Margins

BRF S.A. Boosted By A Strategic Investor, But Operating Conditions Are Challenging

 

I liked the valuation on BRF (BRFS) shares back in March, and the shares have since outperformed (up more than 25% since then, but that outperformance has a great deal more to do with the recent acquisition of BRF shares by Marfrig (OTCPK:MRRTY) than the current fundamentals, as BRF remains pressured by higher production costs and challenging international markets.

I don't see the near-term pressures abating, and BRF is going to be hard-pressed to continue raising prices at the pace of recent quarters (17% to 22%). Likewise, I don't see the international markets getting easier in the near-term.

I do still like the long-term potential of BRF's ongoing turnaround, and the involvement of Marfrig does raise the question (again) of whether BRF could be a merger/takeout candidate. The valuation argument isn't as compelling today, though, and I look it as more of a borderline buy.

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BRF S.A. Boosted By A Strategic Investor, But Operating Conditions Are Challenging

A Welcome Pullback At STMicroelectronics, But The Lead-Time Story Still Carries Risk

 

I went neutral on STMicroelectronics (STM) (“STMicro”) with my last update on the shares, largely because I just couldn’t reconcile the valuations across the sector with the likely growth and margin trajectories. I was also concerned about the high levels of lead-times – a situation that has in the past telegraphed weaker returns from chip stocks as order patterns normalize.

Since that last piece, STMicro shares have declined about 15%, underperforming both the chip sector as well as more specific competitors like Infineon (OTCQX:IFNNY), NXP Semiconductors (NXPI), and ON Semiconductor (ON), though longer-term performance timelines (two years and beyond) still largely favor STMicro over many peers.

I’m a little conflicted on recommending these shares now. I like STMicro’s strong leverage to auto and industrial electrification through not only silicon carbide (or SiC) but other chip types as well, not to mention opportunities in 32-bit MCUs (and embedded processing more broadly), IoT, RF, and sensing. I also like the fact that the shares are back down to a level where I see attractive long-term return potential. What I don’t like is that lead-times are still quite high across the industry and these shares could crack $30 in a correction.

 

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A Welcome Pullback At STMicroelectronics, But The Lead-Time Story Still Carries Risk

More Fear And Uncertainty Around II-VI Isn't So Bad For Long-Term Investors

 I’ve said this many times in the past, but it bears repeating – while “buying the dip” is an often a good-to-great long-term strategy with good companies, it’s not always easy to do it. The markets surely do freak out from time to time and offer up seeming bargains, but most often a “buy the dip” opportunity comes about because there are real concerns in the market about the short-term prospects for the company in question. 

That brings me to II-VI (IIVI). I didn’t like the core fundamental valuation on the shares back in February, though I was still bullish on the long-term prospects for this leading (if complicated) optical and materials technology company. With the shares down about 25% since then on fears that the company is overpaying for Coherent (COHR), not to mention worries about near-term end-market demand and an overall cooling on expensive growth, the shares look a lot more interesting for long-term investors today.

 

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More Fear And Uncertainty Around II-VI Isn't So Bad For Long-Term Investors

Bank Of America's Run Of Outperformance Fairly Values The Longer-Term Opportunity

 

I liked Bank of America (BAC) ("B of A") back in the summer of 2020, as I thought the market reaction to the near-term pressures on the banking sector were extreme relative to the long-term opportunities for this leading consumer and commercial bank. Since then, the shares have largely outperformed most of the bank's mega-cap peers (Citigroup (C), JPMorgan (JPM)) with a roughly 85% total return, though a few (PNC (PNC) and Wells Fargo (WFC)) have done better.

With the run in the shares, I'd say that the market fairly values the opportunity I see for Bank of America. I do expect the company to leverage its strong franchise, scale, and IT capabilities to continue gaining share in the fragmented U.S. banking market, but I don't see the outsized returns I saw before.

 

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Bank Of America's Run Of Outperformance Fairly Values The Longer-Term Opportunity

Lattice Seeing Revenue Acceleration And Moving To Double Its Addressable Market

The Lattice Semiconductor (LSCC) story continues to work, particularly with revenue accelerating nicely in the first quarter and management offering a credible outlook for mid-teens or better growth over the next three to four years. I have had my qualms about paying such a rich price for this stock (currently trading at around 15x expected 2021 revenue), but the shares have continued to outperform the broader semiconductor sector so far this year.

I know some investors were hoping for more operating margin leverage in management’s recent Analyst Day guidance, but I do think the company’s decision to continue investing in R&D and expand into the mid-range FPGA market is a good one for the long-term. I can’t, and won’t, defend the valuation, but I believe the underlying quality of the company and the growth story remain good.

 

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Lattice Seeing Revenue Acceleration And Moving To Double Its Addressable Market

Industrias Bachoco Looks Undervalued On Demand Recovery And Pricing Power

 

It's not easy to earn strong long-term returns from commodity food products. A few companies manage it, Tyson (TSN) being one of them, but it's not the norm and those outlier stories are often driven by some combination of scale leverage and growing premiumization (a shift to higher value-added processed/packaged foods).

That's a risk factor to keep in mind when looking at Mexico's Industrias Bachoco (IBA), but I think there are also positive drivers at play here. Not only does Bachoco run a pretty tight ship where operating efficiency is concerned, but the company also has leverage to positive long-term drivers like organic and inorganic portfolio expansion and increased protein consumption in its primary market as household incomes increase.

I do believe that higher grains prices are a risk, but I also believe they are a well-understood risk and management's efforts on hedging and pricing should reduce the downside risk. If Bachoco can generate long-term revenue and FCF growth on the low end of the mid-single-digits, I believe investors can reasonably expect long-term annualized returns in low-to-mid teens.

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Industrias Bachoco Looks Undervalued On Demand Recovery And Pricing Power